Small Business

Something Ventured, Plenty Gained

August 06, 2003

By Michael J. Mandel As the economy and the tech sector try again for a sustained recovery, remember that the 1990s boom was as much about finance as about technology. The Internet was the star -- but it was the ability of new companies to raise hundreds of billions of dollars in venture capital that supercharged growth and innovation.

Indeed, access to capital played a key role in powering the 1990s surge in tech hiring and spending. Much of the money taken in by young companies went to pay for programmers, new computers, and software. The numbers were huge -- the $90 billion increase in venture finance alone from 1997 to 2000 helped fund the $120 billion rise in tech spending for all businesses.

NASDAQ'S CATALYST. A strong venture capital rebound could be more critical for growth in the coming years than it was in the 1990s. For one, VC funding is starting from a higher base. Venture investments hit a $17 billion annual rate in the second quarter of 2003, up a bit from the first quarter. That's way down from the 2000 peak, but far more than the $4 billion invested annually in 1992-94.

With the NASDAQ stock index up some 25% since March, history suggests that venture capital will soon follow. An additional $10 billion in venture capital -- not unreasonable, with venture firms sitting on about $70 billion in uncommitted funds -- would translate into as many as 85,000 new jobs for programmers, biotech scientists, and the like (assuming salaries and benefits average $120,000 per job and most hiring occurs in the U.S.). Or, if spent on new equipment or software, that $10 billion would add 2.5 percentage points to the growth rate of business tech spending.

Why should venture capitalists, still hurting from recent losses, jump back in? VC investments usually follow the movements of the NASDAQ, the home of most tech IPOs, with a lag of a year or less. That pattern held in the early 1990s, and over the past few years, when venture capital and the market marched in tandem during boom and bust. The reason? Taking startups public is easier when stock prices are rising.

Now, as tech stocks recover, the process is starting again. VCs "have been waiting for a sign that their investments will be worth the time and risk," says Kirby Wadsworth, vice-president for marketing and business development at Revivio Inc., a Lexington (Mass.) startup that just received $21 million in new venture funding. Globespan Capital Partners, an investor in Revivio, expects its overall investments for 2003 to be 50% to 100% higher than in 2002.

GOOD OMENS. Revivio, which is developing a product that will make it easier to back up and restore data, will spend the vast majority of the money on salaries for software engineers and other product development jobs. Other companies are using venture funds to beef up their tech infrastructure. Inphonic Inc., a rapidly growing distributor of private-label wireless services, based in Washington, D.C., just raised $56 million in new venture financing. Part of the money, says CEO David Steinberg, will go to automating customer service, upgrading computers in call centers, and improving financial reporting software. Between now and the end of 2003, capital spending will total $10 million, up more than 100% over a year earlier.

Adding to the impact, higher spending on tech by venture-financed companies could improve sales and profits at tech companies, boosting stock prices and making it easier to raise money. That's what happened in the late 1990s.

Only in the U.S. do the stock market, venture capital, and tech spending reinforce one another like this. And this may be a very good reason to believe in a bright future for tech. Mandel covers the economy for BusinessWeek from New York